CIS Economic Outlook August 2016

CIS: Digesting the impact of Brexit on the CIS

August 3, 2016

The majority of analysts foresee that the Brexit result will only have a mild impact on the Commonwealth’s real economy. The transmission mechanisms to CIS countries will principally be through an economic slowdown in Europe and a drop in commodities prices particularly in oil, gas and industrial metals, which are the region’s main commodities exports. In our most recent Major Economies survey, the Consensus view among analysts is that the recovery in the Eurozone will continue as the brunt of the impact of Brexit is not expected to be felt this year. However, as negotiations will likely be dragged out since European rules set a two-year period for negotiating an exit, analysts see that a worsening in economic sentiment in the common-currency bloc could potentially weigh on growth in 2017 and beyond. Meanwhile, a gradual recovery in commodities prices this year and next is also expected by our analysts, despite the recent Brexit-related hiccups. Nonetheless, prices of raw materials—principally crude oil and gas prices—will be affected if economic activity in Europe slows as a result of a chaotic Brexit.

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Finally, regarding geopolitics, the UK has long been seen as a close partner in managing EU-Russia relations. EU leaders’ immediate reaction to the referendum result was one of disbelief. On top of fears that Brexit could have a negative economic impact on the region, the exit of the UK also means removing a prominent Western hawk against Russia from the EU negotiation table. Brexit touches upon both EU security fears—particularly in the Baltic countries and Poland—and concerns about the future of European integration. EU leaders fear that Brexit could have the potential to set off a wave of “exits” from the Union, which would in turn strengthen Russia’s hand in dealing with a more fragmented Europe.

Contraction softens in Q1, economies undergo painful adjustment

The pace of contraction in the economy of the Commonwealth of Independent States (CIS) moderated in the first quarter. An aggregate GDP estimate showed that the Commonwealth’s economy decreased 1.1% in Q1, which was an improvement on the 3.0% contraction registered in Q4 2015. The less-pronounced downturn at the onset of the year reflected that Russia—the region’s largest economy—was more resilient to heightened volatility in both the global financial markets and the renewed fall in oil prices. Russia’s GDP contracted 1.2% year-on-year in Q1, which came in above the 3.8% decrease observed in Q4 and was better than the 1.4% contraction that Russia’s Ministry of Economic Development had expected. That said, the contraction in the region’s largest economy irrefutably affected other CIS countries’ economic activity: economies such as Azerbaijan, Belarus, Kazakhstan and Kyrgyzstan contracted in the first quarter.

Oil and gas exporters in the Commonwealth are facing a painful adjustment to low oil prices. Despite the recent rally in oil prices, growth in these economies—particularly in Azerbaijan, Kazakhstan, Turkmenistan and Uzbekistan—continues to languish, particularly from a decline in public investment. Governments in these countries have reduced their investment spending as a drop in fiscal revenues from hydrocarbon exports has prompted them to consolidate their fiscal position. Meanwhile, the region’s energy importers—Armenia, Georgia, Kyrgyzstan and Tajikistan—are experiencing sluggish domestic demand as a drop in remittances, mainly from Russia, is still weighing on household spending. That said, the positive developments seen in Russia bode well for a gradual recovery in the region since the ripple effects from a Russian recovery will be felt in the rest of the economies that comprise the CIS. Moreover, the nascent recovery in oil prices will start to alleviate pressure on oil-producing countries’ public finances, ease volatility in exchange rates and boost confidence in the region.

Economic prospects improve for third consecutive month

Overall weakness in the region persisted in the first half of this year, but growth prospects for the second half of the year are brighter. This month, economists surveyed by FocusEconomics raised the region’s GDP growth projection again and now expect the economy of the Commonwealth of Independent States to contract 0.4% this year. The forecast was lifted by 0.1 percentage points from last month’s estimate and marked a third consecutive improvement.

The less negative economic outlook in the region reflects that analysts have raised their growth forecasts for Russia, which is the region’s largest economy. Spillover effects from a recovery in the Russian economy also prompted economists to increase their GDP growth forecasts for Armenia and Moldova, while the economic outlook for almost the rest of the surveyed economies remained unchanged over the previous month. Kyrgyzstan was the only country for which analysts cut their GDP growth projection.

Given that our panelists expect commodities prices to gradually recovery this year and next, they predict that the economy of the Commonwealth will bounce back strongly in 2017 and expand 1.7%.

The government redenominated the Belarusian ruble on 1 July for the third time since gaining independence in 1991, this time by a ratio of 10,000:1, thereby slashing four zeroes off the currency against a backdrop of high inflation and a protracted recession. Although the government has not provided much information on the move, the modification was originally scheduled for 2009 but was delayed in the wake of the 2008–2009 financial crisis. The redenomination mainly aims to facilitate economic transactions. However, the move is not expected to improve confidence in the currency, which depreciated sharply last year. Furthermore, economic activity in Q2 remains lackluster and an ongoing trade dispute with Russia has caused oil shipments into the country to decline by more than 40%, impacting Belarusian exports as a result.

The economy’s outlook is grim. Weak external and domestic dynamics coupled with debt repayments due this year are weighing on growth prospects. Furthermore, remittances inflows from Russia will remain subdued despite signs that economic activity is stabilizing. FocusEconomics Consensus Forecast panelists see GDP falling 1.8% in 2016, which is unchanged from last month’s forecast. For 2017, the panel projects that the economy will rebound to a 1.4% expansion.

KAZAKHSTAN | Following GDP contraction in Q1, weakness persists in Q2

A renewed fall in oil and gas prices at the beginning of this year exacerbated the economic contraction in Q1 and economic activity remained weak in Q2. Data showed that industrial production increased a mere 0.1% year-on-year in June, which followed three consecutive massive contractions. While the latest result was encouraging, it was likely another one-off improvement rather than a sign of the beginnings of a recovery in industrial output. That said, oil prices have rebounded from the lows registered earlier in the year and the rally—notwithstanding the recent hiccups caused by Brexit—is likely to encourage an increase in oil and gas production and, consequently, in exports. Oil production in the Kashagan oil field is due to resume later this year and the government’s ongoing economic program, “Nurly Zhol”, is expected to buttress industrial development and propel investment. In fact, on 5 July, global consortium Tengizchevroil and the government announced a joint investment of USD 36.8 billion to prolong the life of the Tengiz oilfield.

The economic downturn is expected to have bottomed out in H1 and the economy is seen recovering gradually in H2. However, difficulties in Europe in the wake of Brexit and a slow recovery in commodities prices are weighing on the outlook. Economists surveyed this month expect the economy to expand 0.3% in 2016, which is unchanged from last month’s forecast. In 2017, GDP is seen accelerating to a 2.1% expansion.

The economy contracted 1.2% annually in Q1, yet the downturn was softer than expected. More recent data show that parts of the economy are gradually leaving the recession behind. An increase in oil prices from Q1 to Q2 supported a gradual improvement in the Russian industrial sector, and as inflation eased and the ruble stabilized, the decline in real wages moderated. These developments also prompted Russian consumers to be less downbeat in Q2. Russians will go to the polls on 18 September to cast their votes for lawmakers of the State Duma. The election was brought forward from 4 December and the 450 seats in the lower house of parliament are at stake. Debates are scheduled for August and recent polls put the ruling United Russia party (UR) of President Vladimir Putin in the lead. That being said, analysts suggest that the current economic difficulties could cost UR its top position in the Duma. The results of the election will also shed some light on the political mood ahead of the more relevant presidential election scheduled for March 2018.

The Russian economy has gone through a painful adjustment and its contraction seems to have bottomed out in H1. Economic activity is seen as strengthening gradually in H2 and analysts project that GDP will contract 0.8% in 2016, which was revised up by 0.1 percentage points over last month. Nonetheless, risks to the outlook remain due to the slow recovery in oil prices and the uncertainty associated to Brexit. For 2017, analysts see the economy rebounding and expanding 1.4%.

UKRAINE | Growth remains fragile and IMF delays aid

Ukraine’s battered economy disappointed in the first quarter, managing only a meagre expansion despite extremely supportive base effects. Recent data suggest that the economy closed Q2 on a weak note as industrial production returned to contraction after four months of increases. Despite some improvements in the state of the economy this year, the country remains reliant on external support, which continues to be delayed. In July, an expected payment of over USD 1 billion from the IMF was postponed over technical issues. Meanwhile, Ukraine will likely feel some Brexit pain through the expected slowdown in the European Union—a key export destination. In addition, the country’s political ambitions to become further integrated with the EU could be put on hold as the Union focuses on the UK’s withdrawal.

GDP is expected to return to growth this year after two years of steep contractions. However, downside risks will remain elevated until durable peace and political stability are achieved. The FocusEconomics panel sees the economy growing 1.2% this year, which is unchanged from last month’s forecast. For 2017, the panel sees GDP growth accelerating to 2.4%.

INFLATION | Inflation rises again in June

Inflation in the Commonwealth of Independent States rose for a second consecutive month in June. According to a regional estimate, inflation edged up from a revised 8.0% in May (previously reported: 7.9%) to 8.2%. The higher reading in June was mainly the result of higher consumer prices in Azerbaijan, Kazakhstan, Kyrgyzstan, Russia and Tajikistan.

Analysts expect that inflation will moderate in the coming months. FocusEconomics experts project inflation in CIS to end this year at 7.4%. This month’s forecast was cut by 0.2 percentage points over the previous month’s Consensus. Looking forward, analysts predict that inflation in the region will fall further to 5.9% in 2017.

Written by: Ricardo Aceves, Senior Economist

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